statistics, mathematics, management

These two “competitive advantages” could be about to crumble

Purplebricks(LSE: PURP) has taken the UK housing market by storm. The business model has turned the traditional approach on its head, rejecting expensive brick-and-mortar agencies for online services.

This lean business model has allowed it to undercut the competition by a devilish amount. Usually, when estate agents helps sell your property they will take a percentage fee. Purplebricks has discarded this approach in favour of a flat rate for any property, regardless of value. For only £849, the seller gets a local agent, listings on all major websites like Rightmove and access to one of the UK’s largest databases of buyers.

Its competitive advantage stems from its ‘first mover’ status, but I’m not sure it is durable. You see, a lot of companies that create superior processes go on to earn superior returns. Inevitably, these outsized returns attract competitors to the industry, driving down profitability for everyone involved.

Have you heard of Hatched, House Simple, House Network, My Online Estate Agent, Settled, Tipilo or Yopa? Well, if you’re an investor in Purplebricks you probably should have done, because according to Which? they all provide similar services. Here’s the comparison page.

Oh, and that last one, Yopa, was launched by upmarket estate agent Savills. If you thought the industry would just lie down and die, you were wrong. I don’t enjoy deterring investors from genuinely interesting and useful businesses, but I worry that this business model is not patentable or protectable.

The company’s best chance at domination, however, is the network effect. This describes any network that becomes more valuable as more people join it. Purplebricks’ network of buyers using the app could represent a durable advantage if it can reach critical mass before competitors do. But it must do this before a rival with financial firepower turns up and makes this a harder race.

If the network falls behind that of competitors, the brand will not protect sales and I believe Purplebricks will experience an incredible hotting-up of competition in the future. At the end of the day, people will flock to the platform that has the most economic benefits.

Brands are overrated

Sky(LSE: SKY) is a good example of this in another sector. The internet has opened up the television industry to a myriad of new competitors, not least among them Amazon Video and Netflix. The battle for content is hotting up – and that means Sky will likely have to spend more to keep its services appealing to its customers.

The company has long relied on expensive sports rights to drive business, but these rights are up for auction every few years, meaning the future is hard to predict. Competitor BT secured the Champions League rights back in March, but it cost it £1.18bn – nearly £300m more than it paid last time around. This spending only lasts until 2021, when the bidding begins anew and Sky faces the same issue.

Sky’s churn rate increased more than a full percent last year from 10.2% to 11.6%. Admittedly this is still a very low rate, but I believe it to be symptomatic of younger generations avoiding costly bundled deals offered in favour of all-inclusive offerings from Netflix at less than £10 a month.

I reckon Sky will flourish for some time yet, but it must evolve if it wants to stay relevant in the long term.

Analysing the durability of a company’s competitive advantage is certainly not easy, but we believe it is perhaps the most important aspect of investing for the long term. Yesterday’s big winners can appear very mediocre today. When was the last time you saw a Blackberry, for example?

Our top analysts have found five companies with a durable competitive advantage that could drive long-term outperformance. Spread across different industries, these companies have one thing in common: consistency. To download the free report, click here.

Zach Coffell has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

One of my duties is to coordinate quality control objectives and activities to resolve production problems, maximize product reliability, and minimize cost. I also love baking on weekends with my kids.